Ag downturn exposes vulnerabilities, offers opportunities

As the declining agricultural economy continues to seek a bottom, some farmers and ranchers may be poised to take advantage of opportunities created by the downturn. “We see opportunities for those in position to take advantage,” says Michael Boehlje, with the Center for Food and Agricultural Business at Purdue University.

A featured speaker at the recent Oklahoma State University Rural Economic Outlook Conference on the Stillwater Campus, Boehlje said economic downturns offer opportunities, but they also expose vulnerabilities. The difference, he says, is with farmers who plan for the decline while enjoying the upswing. A boom can be followed by a bust or a downward correction, and producers must prepare for the other side of either situation.

The current trend is down, with farm income declining 11.5 percent — $71.5 billion in 2016, compared to $121 billion in 2014. Part of the problem for agriculture, Boehlje says somewhat tongue-in-cheek, is that the U.S. has “too many old people who draw more out of the system than they contribute,” and those who continue to work may not be as productive (he admits that he himself has no spring chicken credentials).

Growth rate has slowed, with less population growth, he says. “We need to accept a 2 percent growth rate in the economy. Also, when put into a historical perspective, a farm income of $71 billion is not that bad.”

LOW PRICES, HIGH COSTS

But as commodity prices have declined, production costs have not followed suit, and Boehlje says many Midwest producers remain focused on 2012, when per acre profits were pushing $250 per acre.

“What did many of them do with those profits? They bought iron. They didn’t save it — and that is important.” But, he says, some did hang onto profits, and they are the ones in the best position to weather the farm income decline.

“This industry goes in cycles,” Boehlje says, “and farmers need to be in position for the other side of the cycle. They also must remember that costs don’t come down as fast as prices.” He estimates recovery will not occur until 2018/19.

“We have just experienced a boom in agriculture. Are we now in a bust? I don’t think so.”

Rather, he says, agriculture has expanded. “We have built a bigger plant, with more acreage under the plow, as producers look for volume to cover high fixed costs. They have to pay the bills, even though the cost of production per bushel (Midwest corn) guarantees a loss on all 2016 production. Should they just shut down the farm?”

Not likely. Boehlje says corn would have to go below $2 a bushel to see any significant acreage reduction. “Building a bigger factory means we keep on planting. We look for growth in demand to pull up the market. We’re not hopeful.”

The recession of 2008 through 2012 hurt demand, especially for meat and poultry, particularly red meat. Herd size also was reduced, but now is building back capacity faster than demand is expanding. Animal protein markets are in negative positions, losing $248 per head in late October.

He says the beef industry “lost as much equity in the last two years as it generated the three or four years before.”

FINANCIAL VULNERABILITIES

Agriculture is showing some critical financial vulnerabilities, including an erosion of working capital, Boehlje says. Capital is a farmer’s “first line of defense against financial stress.” Too many farmers don’t have cash. “The real value of cash — working capital — has nothing to do with its earning potential.”

Cash provides a safety net. “We have about two more years of excess working capital in the grain industry before we hit the wall,” he warns.

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Farmers who rent acreage are more vulnerable than those who own it, he says. “They have no backup when they refinance. They have increased tax burdens and high capital expenses. And, refinancing does not resolve problems, but buys time.”

Farmers may be in for tax trouble in 2016, Boehlje says. “Some pushed tax obligations forward over the past few years, and those obligations are coming due. Producers who held grain for sale from one year to the next may have created a tax burden at a time when they can’t afford it.”

Farmers are looking at tight repayment capabilities and short repayment schedules on equipment and land loans at a time when they have reduced income and less cash flow.

FEW DEFAULTS EXPECTED

Boehlje doesn’t anticipate widespread bankruptcies and foreclosures, however. “Generally, the industry is still strong, but weakening for highly leveraged entities. We may see a few defaults and bankruptcies in those situations. We are in a downturn, but nothing like the 1980s.”

Producers who are not highly leveraged and still have working capital may find opportunities to expand or upgrade. “Downturns provide opportunities,” he says. Opportunities may include reduced asset values for land, machinery, and equipment. Acquisitions may be more available, and new business ventures may be possible.

The rental market may be in flux, he says, “But producers should be ready to walk away from rental property if they know going in that they will lose money on the land. It’s a hard decision — but do the math.”

One of the most important actions farmers can take during a downturn, Boehlje says, is a critical self-appraisal. “Farmers typically don’t do this very well; it’s hard to evaluate one’s own key assets.”

Managers often over-value those assets, especially land and labor, he says. “They all say they have the best land and the best people, but that’s often not true.” Assessments should include scrutiny of resources and capabilities, including management capacity, physical assets, capital assets, staffing, and risk tolerance. Producers should ask themselves if they should tighten down to save money, or lose the least amount possible. And they should determine if it’s feasible to pursue new opportunities, and if so, which ones would be the best.

“Do this assessment before you visit your banker,” Boehlje says. “Also, know how to handle transitions, and decide who takes over. How well will they be trained, and will they have the skills you possess?”

PURSUE OPPORTUNITIES

Producers in a position to add opportunities should pursue them, he says. “Don’t wait for them to come to you — brainstorm new opportunities.”

The same tools other businesses use in management apply to agriculture, he says. “Look at potential ventures, and determine if one fits, and whether it fits with where you’re trying to take the business. Look for opportunities in service. Look for a cultural fit and consider if the operation can handle the added complexity of a new venture. Make sure the deal fits, too.”

A strategic fit is paramount, Boehlje says. “It takes far more time to unwind a bad decision than it does to make sure it fits with your business in the first place.”

Tough times demand tight management. “How do we win in tough times?” he asks. The process includes resiliency, an ability to protect the position of the operation — defense. It also includes the agility to capture the upside —offense.

A producer needs “a war chest full of cash, low fixed cost, a diversified cash flow, unique hard assets, size and an ability to downsize, and moderate and properly structured debt. He must use assets wisely. “A combine is too expensive to use only 12 hours a day during harvest season,” he says. And he notes that agriculture is now “a biological manufacturing plant” that needs to be run like a factory, at the lowest cost possible.

FINANCIAL RESERVES

Financial reserves are essential, Boehlje says, as is maintaining top personnel and equipment. Providing unique products or services to a buyer will create a loyal customer “who can’t switch. Brand is important to protect that core market and prevent others from encroaching — “Be a preferred supplier.”

Production agility requires a strong balance sheet and cash reserves as well as an ability to respond rapidly. A long term management view is important as is anticipation of market changes. A willingness and an ability to exit a poor venture is important, but so is a startup mentality. Experimentation should be an ongoing aspect of the operation.

Before a producer adds a new enterprise he should develop an exit plan. “Put it in writing before adding the venture.”

The operation should have a diversified portfolio, a deep and flexible management team, and a willingness and an ability to reallocate resources. “If an enterprise is not making money, reallocate resources to one that does.”

Boehlje says producers should make “regular and unbiased evaluations of the operations and structure them for exits and downsizing.”

Other important considerations include clear performance goals; collecting data on performance and market conditions; focused priorities with management, and labor not spread too thin; a workforce that is held accountable and is adequately rewarded; an ability and willingness to experiment and take calculated risks. “Exit the enterprise if it does not work.”

Boehlje concedes that agriculture is in a tough economic downturn. But he also contends that opportunities will return. Potential market prospects in China and other developing countries create significant export potential and opportunity to grow income, he says. “That’s why I’m optimistic about the future of agriculture.”